Central parsimony

In the last few weeks, the Union government has, on more than one occasion, given a clear indication of how it wants the states to share the incremental financial burden of any scheme that it proposes to introduce. It seems the Centre's fiscal relations with the states have entered a new phase. The states continue to demand more resources from the Centre, but the latter now is keen that any additional transfer - outside those made under its constitutional obligations - would be subject to the states sharing the extra burden.

The Centre's decision to decontrol the sugar industry is a case in point. The government has not dismantled the public distribution system (PDS) for sugar, but it has freed the sugar mills from the burden of supplying a portion of their total sugar production at a government-determined price. In other words, the burden of the subsidy on sugar supplies through PDS would be borne by the Centre. The catch is if the market price of sugar increases beyond a stipulated level at any point in time, the extra burden of subsidy has to be borne by the states where such supplies are taking place. The Centre will, thus, cap its share of the sugar subsidy burden, expecting the additional financial load to be borne by the states.

The states are having a similar experience with the proposed implementation of the food security law. Yes, the Centre will bear the burden of the food subsidy, provided the states supply the food grain at the price fixed by it. But if the states were to supply the foodgrain at a price lower than what the Centre has fixed under the law, the additional subsidy burden would have to be borne by the states. Once again, the Centre is keen to cap its financial burden on account of this scheme.

Even with regard to the central scheme for bailing out debt-ridden power distribution companies in various states, the same principle was in use. Fifty per cent of the state power utilities' debt was to be converted into bonds, but these were to be guaranteed by the states. Once again, the Centre was willing to facilitate a financial bailout for state power utilities, but the additional cost of the entire operation had to be borne by the state governments.

Why has the Centre become such a strict disciplinarian, if not parsimonious, while dealing with the states? This was not so even a few years ago. It was common to see a benevolent Centre grant financial freebies to the states in dire straits. The Union government, of course, continues to selectively grant special financial assistance to some states, but increasingly, the states are now encouraged to pay for the extra benefits they would get from the central schemes. With not much scope for discretion in the new system, the states would obviously complain about the new arrangement.

One possible reason the Centre has moved towards the new system is because it no longer enjoys a comfortable financial cushion to provide such freebies to the states. Instead, the states are in much better fiscal health. This is a little ironical since the Centre had initiated the drive towards fiscal consolidation and the states only followed that road map for fiscal discipline much later. Indeed, even as the Centre's fiscal health has steadily deteriorated over the last few years, the states have seen a clear improvement.

A study conducted by the Reserve Bank of India shows that with regard to institutional reforms in public finance, the states have made rapid strides. Since its launch in 2005, all states have implemented the value-added tax system. The first state to enact the fiscal responsibility legislation was Kerala in August 2003. Since then, all states have subjected their governments to the financial discipline - of a fiscal responsibility and budget management legislation. Significantly, the last two states to have enacted the law were West Bengal in July 2010 and Sikkim in September the same year. As many as 25 states have agreed to impose a ceiling on the guarantees they offer on loans.

Not surprisingly, the states' deficits have remained largely under control. The combined gross fiscal deficit of the states was 2.3 per cent of the gross state domestic product (GSDP) in 2011-12, and this would decline further to 2.1 per cent in 2012-13. Similarly, the states have been enjoying a revenue surplus for the last three years. Remember that the improvement in the states' finances has taken place not just because of a rise in their own tax revenues (up from six per cent to 6.3 per cent of GSDP in the last three years), an equally important factor has been the rise in the transfer of resources from the Centre to the states - up from five per cent to 5.6 per cent of GSDP in the same period.

If the Centre today is reluctant to share the entire incremental burden of its various schemes, it is because of the realisation that the states can now bear it since they are in better financial health, thanks to the recommendations of successive finance commissions, which have raised the quantum of central resources that should devolve to the states, and their own tax mobilisation efforts. The parsimonious Centre today is also a sign of a government worried about its own deteriorating finances.